Eco 200 – Principles of Macroeconomics

1. Eco 200 – Principles of Macroeconomics Chapter 14: Monetary Policy

2. Federal Reserve System • Debate over central bank – First and Second National Banks • Federal Reserve Act – 1913 • 12 District Banks • Board of Governors – 7 members - 14 year “non-renewable” term • Chair of Board – 4-year term – does not coincide with President’s term – “second most powerful person in the U.S.” • 12 District Banks – 9 person board (6 elected by members banks in the district, 3 appointed by Board of Governors) • Federal Open Market Committee – 12 members (Board of Governors + 5 District Bank Presidents selected on a rotating basis, but always including President of NY Fed)

3. Fed autonomy • Autonomous? • 14-year terms • The President does not appoint a majority of the board in a single term in office • No need for budget request from Congress • Autonomy created by act of Congress and may be removed by an act of Congress.

4. Functions of the Fed • Provides banking services and supervision • Supplies currency • Holds reserves • Clears checks • Makes loans to banks (discount loans) • Controls the money supply

5. Implementing monetary policy • Policy goals: economic growth, low unemployment, and price stability • Intermediate targets – objectives that are used to help achieve policy goals (examples: money supply or interest rate targets)

6. Equation of Exchange • MV = PY • M = quantity of money • P = price index • Y = real GDP • V = # of times a typical dollar is used to purchase GDP = PY / M • Quantity theory of money • V is constant (and Y is constant in the long run) • Changes in M result in changes in proportionate changes in nominal GDP (and only in the price level in the long run)

7. Tools of monetary policy • Reserve requirement • Discount rate (also affects the federal funds rate) • Discount rate – interest rate charged by Fed on loans of reserves to banks • Federal funds rate = interest rate charged by banks on loans of reserves to other banks • Open market operations – buying or selling government bonds (most commonly used tool of monetary policy)

8. Monetary policy • To expand the money supply, the Fed may: • Lower the reserve requirement ratio • Lower the discount rate • Buy government securities

9. Foreign Exchange Market intervention • Buying or selling currencies to maintain target exchange rate • Shown on board • Sterilization – open market operations to offset the domestic money supply effect of foreign exchange market intervention

10. Money demand • Reasons for holding money: • Transactions demand • Precautionary demand • Speculative demand • Quantity of money demanded: • Rises as nominal income rises (a higher price level or higher real GDP results in an increase in demand) • Declines as the interest rate rises

11. Money demand

12. Money demand and income

13. Money Supply

14. Equilibrium

15. Monetary transmission mechanism: Keynesian model

16. Monetary transmission mechanism (cont.)

17. Monetary transmission mechanism (cont.)